Singapore Aviation Services - Maybank Kim Eng 2019-09-02: Traffic Stats ~ Ain’t No Sunshine

Singapore Aviation Services - Maybank Kim Eng Research | SGinvestors.io SIA ENGINEERING CO LTD (SGX:S59) SINGAPORE TECH ENGINEERING LTD (SGX:S63) SATS LTD. (SGX:S58)

Singapore Aviation Services - Traffic Stats ~ Ain’t No Sunshine

Humdrum YTD traffic numbers, but we upgrade SIA Engineering

  • June visitor growth was a mere 0.4% y-o-y while July air traffic fell 0.9% and cargo volumes shrank 7.2%. July passenger growth of 3.1% was the only bright spot with the effect of Changi’s T4 capacity expansion continuing to play out.
  • Despite the lackluster growth outlook for Singapore for 2019, we remain positive on the sector as the stocks are well diversified geographically and have demonstrated earnings resilience in past downturns. Upgrade SIA Engineering (SGX:S59) to BUY from HOLD.

China visitors no longer the problem; ASEAN, India are

  • Visitor growth slowed down in Q4 2019 due to the drop in Greater China arrivals but March-June saw a rebound in Chinese visitors at 4.6-7.0% y-o-y. The weak growth now stems from ASEAN and South Asia. ASEAN visitors contracted y-o-y through the second quarter due to declines from its two largest origin markets of Malaysia and Indonesia that make up for c45% of ASEAN visitors.
  • Meanwhile, another large block that has been uncharacteristically weak YTD is South Asia due we weak visitor arrivals from its largest component i.e. India.

Cargo looks ugly and it’s affecting flight volumes too

  • July air cargo throughput through Changi contracted 7.2% y-o-y. It’s the ninth straight month of contraction while the YTD-July decline of 6% is the worst since the GFC in 2009. Commercial flights at Changi were down 0.9% y-o-y in July with the YTD contraction at a similar magnitude of 0.8%. We surmise this was largely due to the collapse in cargo volumes to a large degree.
  • While there is no granularity provided between types of aircraft traffic, we estimate roughly 10-12% of flight traffic through Changi are freighters.

Visitors: June saw further growth deceleration

  • June 2019 visitor arrivals grew marginally at just 0.4% y-o-y in a continuation of the growth slowdown that started in Q4 2018. Jan-June 2019 visitor growth stands at 1.4% y-o-y.
  • The slowdown started with Greater China arrivals contracting in late-2018 but this has since rebounded with recent months March-June registering 4.6-7.0% y-o-y growth in Chinese visitors.
  • The weakness now stems from ASEAN, the largest SG arrivals block, contracting during the second quarter due to visitor declines seen from its two largest components Malaysia and Indonesia which make up for c45% of ASEAN visitors.
  • Another large block that has been uncharacteristically weak YTD is South Asia driven by a contraction in a number of months from its largest component i.e. visitors from India.

Changi passengers: still outpacing visitor growth

  • YTD passenger traffic growth at Changi Airport was the only bright spot in the aviation traffic statistics, outpacing visitor arrivals by 2.5x.
  • However, growth here is slowing too: July 2019 growth of 3.1% y-o-y was at much lower levels compared to the c5-6% witnessed through most of 2018. However, this deceleration is in part expected largely due to the high-base effects of last year when Changi Terminal 4 had its first full year of operation lifting the hub’s passenger capacity by almost 20m to a total of 85m.

Changi cargo: no panacea to the pain

  • July 2019 air cargo throughput through the Changi hub fell 7.2% y-o-y, the ninth straight months of contraction. Jan-July 2019 registered a decline of 6%, the worst since the GFC in 2009.
  • But this is not unsurprising in light of the weakness witnessed for many months now in Singapore’s manufacturing activities and export data releases. We believe a part of this air cargo volume contraction is to do with inventories being wound down given the stated lack of order visibility for the tech downstream companies in Singapore and also potentially the diversion of trade from the US-China trade war.
  • We note that SATS gateway services revenue grew 12% for quarter ended June 2019 versus the air cargo volume contraction of 7.6% during the quarter highlighting a point stated in our prior notes i.e. Singapore’s aviation services companies are relatively resilient to the domestic volume trends due to diversification to numerous overseas markets.
  • SATS is exposed to cargo volumes at Changi through its exposure from managing one of Changi’s cargo terminals and we estimate this accounts for 7% of revenues at most. It also has a minority stake in one of Hong Kong International Airport’s air cargo terminals.
  • SIA Engineering and ST Engineering have no direct exposure to cargo volumes.

Changi air traffic: affected by cargo contagion

  • Commercial flights at Changi were down 0.9% y-o-y in July 2019, while YTD it fell by a similar small 0.8% decline.
  • While the data granularity does not include passenger versus cargo aircraft, we surmise that this decline was largely driven by lower cargo aircraft frequency given the collapse in cargo volumes (we estimate around 10-12% of commercial flights through Changi to be freighters). On passenger aircraft, OEM delivery schedules indicate a net c2% increase in APAC passenger aircraft fleet in 2019, driven by a c12% net fleet increase for the region’s LCCs.
  • Both SATS and SIA Engineering are exposed to commercial flight frequency at Changi. ST Engineering has no exposure to flight frequency.

Upgrade SIA Engineering to BUY

  • SATS (SGX:S58), SIA Engineering (SGX:S59), ST Engineering (SGX:S63) is our order of preference.
  • We believe Singapore’s aviation services firms are better equipped to deal with visitor volatility than other tourism-related segments such as hospitality, retail and entertainment etc.
  • As highlighted in our previous notes, this resilience is demonstrated by SATS Gateway and SIA Engineering line maintenance revenues. The variables are most closely correlated to Singapore’s aviation traffic, delivering revenue growth of 1.1-5.3% during the past material downturn in visitor volumes starting early 2014, which saw consecutive quarters of contraction by 0.3-6.1% y-o-y,
  • All three companies are also quite diversified geographically with overseas operations that we estimate contribute c10-40% of profits.
  • Market chatter over the possible privatisation of SIA Engineering has faded and consequently the stock has fallen 14% over the past two months. The 1Q20 results were in line with our expectations with core PATMI achieving 25% of our FY20 forecast and we see no change to our outlook for operating fundamentals to justify this share price decline.
  • SIA Engineering offers value at current levels providing 18% upside potential and a defensible 5% FY20E dividend yield based on 80% payout levels. The balance sheet net cash (SGD576m) to equity stood at 36% at the end of the recent quarter, translating to an ex-cash FY20E P/E of just 12.7x.
  • Our SGD2.85 Target Price is DCF based (unchanged 8% WACC; 2% TGR). We upgrade SIA Engineering to BUY from HOLD.
  • SIA Engineering’s franchise strengths are somewhat underappreciated we believe. We expect Singapore Changi to maintain its position as the leading aviation hub in Southeast Asia. And although structural changes to the MRO business have posed various challenges, we also note SIA Engineering’s maintenance market share at its Singapore home base has held steady at c78% over the past three years; this provides scale advantages that we believe other operators will find hard to compete with.

Key risks to our view

  • Some of the key downside risks to our positive thesis, stock picks, forecasts and valuation estimates are:
    1. intensifying price competition from smaller players struggling with excess capacity;
    2. OEMs getting aggressive in expanding in aftermarket MRO;
    3. a significant and prolonged contraction in air traffic, triggered by pandemic events, like avian-flu and SARS, etc.;
    4. a sharp rise in labour costs, driven by unforeseen events (as was the case during the Middle-East conflict during the last decade);
    5. poorly executed acquisitions (in particular ST Engineering and SATS are quite active with acquisitions);
    6. significant and prolonged disruption to airborne cargo growth, driven by the US-China trade war affecting SATS’ cargo operations and ST Engineering’s aircraft conversion business.

See attached PDF report for summary of aviation services offered by ST Engineering, SATS, SIA Engineering.

Neel Sinha Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2019-09-02
SGX Stock Analyst Report BUY UPGRADE HOLD 2.850 SAME 2.85